Can You Carry the State of the States Conversation?

Much of today’s investing headlines focus on the potential implications of new policy initiatives and the impact on the broad markets. Some markets get less press and are more nuanced. How comfortable are you discussing today’s public policy headlines as it relates to the municipal bond market?

We asked Craig Brandon, co-head of municipals and portfolio manager on the municipals team, to share his insights on the impact of federal funding cuts and tariffs on munis.

Q: What do federal funding and jobs cuts/freezes mean for the municipals market?

A: Except for a few sectors in and around munis, we generally think that there’s more of a downgrade risk than a default risk for munis, given the state of the states. That means that while there may be some volatility, muni investments continue to be a potentially attractive area for most investors. States have had a couple of years of record revenue growth, a lot of which came from funding to stabilize the economies and the credits over the course of COVID. As we go into 2025, most states on average have rainy day funds of 15% of 2025 expenditures. That’s a pretty solid cushion to fall back on in case of economic slowdown or cuts to federal funding, which is what everyone is talking about right now.

Healthcare is one of the biggest sectors that could be impacted by a spending freeze because Medicaid is a joint federal/state program. There is a very large range of how much each state contributes toward Medicaid which creates an uneven impact in the event of a spending freeze. In some states, as much as 82% of their Medicaid budget comes from the federal government. All states currently receive at least 50% federal funding for Medicaid. States that rely more heavily on federal funding are more at risk if we see significant cuts to federal Medicaid funding. Higher education is the second sector at risk because larger universities could see substantial cuts to research funding while smaller universities could see less direct federal funding for student aid.

Q: How might tariffs impact state budgets and revenues?

A: We are watching the agricultural states closely. While most people think of the Midwest as the largest exporter of agricultural products, California is the largest. Given California’s diverse economy, tariffs will most likely have a lower direct impact to California state revenues. Other large agricultural exporter states such as Iowa, Illinois, Minnesota, Nebraska and Texas may likely see a bigger direct impact to revenues.

Beyond that, port authorities in coastal states could potentially suffer because of tariffs if fewer goods come into their ports. There are two types of ports in the US: 

• Landlord ports where the port operator has long-term contracts with exporters and importers who are contractually required to make payments for use of the ports regardless of shipping volume. It’s unlikely that a company would break a long-term contract and lose access to a port, especially if tariffs could be removed or reduced in the future. Los Angeles, Long Beach, Port Authority of New York/New Jersey and Seattle all fall into this category.
• Operator ports that derive revenues from shipping volume could be more at risk to a potential slowdown in volume.

During the 2018 tariffs, export countries like China rerouted exports to the US through other countries such as Vietnam. The Trump administration is less likely to let that happen this time but it’s something we’re watching.

Q: What is the context to discuss the “state of the states” with clients and prospective clients?

A: The state of the states conversation should primarily be about which states are best equipped to support their local governments, school districts, hospitals, colleges and universities or other credits that rely on both federal and state support. The states entering these challenging times in the strongest financial position will be able to help issuers within the state manage potential negative impacts from any actions at the federal level.

Bottom Line: Be prepared to carry the conversation and provide sound counsel across the investing landscape.